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Advocates of government stimulus are running victory laps before
the race is even over. In particular, Paul
Krugman compares the sluggish growth in Europe to the
somewhat-less-sluggish growth in the US to prove that stimulus
was more effective than austerity. Other economists are using
government inflation measures to vindicate Fed Chairman
Bernanke's easy-money policy. The only problem is, they're
calling the race before the finish line is even in sight.

As usual, Paul Krugman overlooks basic economics, which, despite
his Nobel Prize, is a science about which Mr. Krugman really
knows very little. The reason stimulus is so politically popular
is that it appears to work in the short-term. However,
appearances can often be deceiving, as they are right now in the
US. Stimulus merely numbs the pain of economic contraction, as
the underlying illness gets worse. The bitter taste of austerity
is not nearly as pleasant to swallow – but it works. America has
chosen the former and Europe the latter (albeit not quite as
large a dose as needed). The fact that in the short-run Europe is
suffering more than the US does not vindicate Washington's
approach. On the contrary, this is exactly what is to be
expected.

The true test is not the immediate effects of stimulus or
austerity, but the long-term results. For that reason, Krugman’s
conclusions are meaningless. The apparent success of stimulus
simply results from spending more borrowed money on government
programs and consumption. But don't we all agree now that this is
exactly what caused the financial crisis in the first place?

As far as inflation is concerned, a vindication of Federal
Reserve Chairman Ben
Bernanke is equally premature. First of all, it’s not
that Quantitative
Easing will lead to inflation; it’s that
QE is inflation. Secondly, there is a lag
between QE and rising consumer prices, so the jury is still out
as to how high consumer prices will ultimately rise as a result
of current and past Fed policy mistakes.

But even more fundamentally, it is absurd to look solely at
government price measures, which are built to understate
inflation, and conclude that QE has not already produced an
elevated cost-of-living . For example, the 2.4% rise in the
Personal Consumption Expenditure (PCE) Index in 2011 is more of
an indictment of the accuracy of the index than a vindication of
Bernanke. In fact, of all the ways the government purports to
measure inflation, the PCE is perhaps the most meaningless, as it
relies on built-in mechanisms like goods substitution to hide a
lower standard of living. For an example of how this works,
imagine you are used to eating farm-fresh butter but have to
switch to cheaper but also less-healthy margarine from a factory;
the PCE would say you are no worse off. That's exactly why the
Fed chose to use this uncommon metric.

Mark
Gertler, an economics professor at New York
University, argues that even the Consumer Price Index, which
rose at a more vigorous 3.2% in 2011, proves Bernanke’s critics
wrong. According to Gertler, the CPI has risen at an average
annual rate of 2.4% thus far under Bernanke’s tenure,
significantly less than the 3.1% average under Alan
Greenspan, and the 6.3% under Paul
Volcker. However, Gertler overlooks two key points.
First, the methodology used to calculate the CPI was much
different during the Volker era. If we still calculated the CPI
the way we did then, the numbers would be much higher for both
Greenspan and Bernanke. Second, given the huge economic
contraction that has taken place under Bernanke, consumer prices
should have fallen – significantly. The fact
that they rose anyway indicates tremendous inflation.

Of course, the Fed’s ability to stimulate the economy with
inflation only works as long as bondholders remain ignorant of
their plan. For now, the seemingly hopeful news reports are
giving the Fed cover to keep stimulating. As long as the market
remains convinced there is no inflation, the Fed can continue to
create it. However, once the effects are so pronounced that even
the PCE can no longer hide them, the Fed will be in a real bind.

Regardless of what the triumphant Keynesians would have you
believe, the truth is that the current combination of monetary
and fiscal stimulus will likely lead to disaster. Instead of a
real recovery, the US will experience an inflationary
depression. Europe, on the other hand, will suffer much
less, precisely because it was not seduced by the short-term
appeal of stimulus.